SMART MOVES TO MAKE BEFORE YEAR-END
Kiplinger's Personal Finance|December 2021
There’s still time to save money and shape up your personal finances before the clock strikes 12 on New Year’s Eve.
1 Tune Up Your Portfolio

ADD REBALANCING TO YOUR ANNUAL TO-DO LIST

Thanks to a bull market in stocks that has stretched deep into its second year, stocks have trounced bonds since March 2020, when the relentless climb began. As of early October, the S&P 500 index has more than doubled, compared with a 4.2% return for U.S. bonds, as measured by the Bloomberg U.S. Aggregate Bond index. But there’s a potential downside to the big rally: Many investors might be holding a bigger stake in stocks than their risk tolerance calls for. And that could make portfolios more vulnerable to a stock market downdraft.

There’s an easy fix: Rebalance your portfolio to get your asset weightings back in line with your desired allocation. “Rebalancing prevents you from taking unintended risks,” says Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management.

Start by tallying up the total dollar value of the stocks, bonds and cash you hold in your taxable and retirement accounts. If you own a fund that invests in both stocks and bonds, such as a balanced fund or target-date fund, review the fund’s latest holdings to see how much it holds in each major asset class. To find out your current asset mix, calculate the percentage of each asset class relative to your total portfolio. For example, if you have a $1 million portfolio and $750,000 is now held in stocks, your equity stake is 75%.

A portfolio that started out in March 2020 with 60% stocks and 40% bonds now is closer to 75% stocks. Trim stock holdings that have gone up in value the most and funnel the proceeds into bonds or cash to get your portfolio back to your target weightings. To minimize your tax bill for sales in taxable accounts, consider offsetting gains by lightening up on losers (see the next page).

TAKE ADVANTAGE OF VOLATILITY

A relatively calm 2021 stock market turned volatile in a big way this fall, with a number of nail-biting days. When stock prices bounce around, dollar-cost averaging, a strategy that involves investing a set amount at periodic intervals, helps in two ways. First, it lowers your average cost per share because you buy more shares when they are cheaper. Second, it takes the emotion out of investing—a challenge when volatility dominates the headlines.

Say you put $1,000 per month into a stock that starts out at $25 a share, then dips to $12.50 the next month before jumping back to $20 and then to $30 in months three and four. After four months you’d own 203 shares at an average cost of $19.70 each. Had you invested the whole $4,000 at once, you’d have paid $25 a share for 160 shares. Perhaps more important, committing to automatic monthly installments would have kept you from second-guessing yourself when the stock hit a low ebb.

PREPARE FOR HIGHER INTEREST RATES

Rock-bottom interest rates have been a fixture of the fixed-income market for years. But a gradual liftoff is under way. The Federal Reserve has signaled it will begin to reduce its purchases of Treasury and mortgage-backed bonds, and it could start hiking its benchmark short-term rate in 2022. “My guess is one rate hike at the end of 2022 and three rate hikes for 2023,” says David Kelly, chief global strategist at J.P. Morgan Asset Management.

Long-term rates, more responsive to expectations for strong economic growth and rising inflation, are already higher, with 10-year Treasuries yielding 1.6% in early October, up from less than 1% at the start of 2021. “Yields will move higher, irregularly and over time,” says Bob Doll, chief investment officer at Crossmark Global Investments. “The pattern we’ve seen so far is two steps up, one step back, then two steps up.”

Because bond prices dip when rates are rising, income investors face a challenge. With Treasury bonds, choose short maturities, which are less sensitive to rate swings. Or stick with assets that hold up relatively well in a rising-rate environment. Doll likes TREASURY INFLATION-PROTECTED SECURITIES, which you can purchase directly from Uncle Sam at www.treasurydirect.gov or via a low-cost fund such as SCHWAB U.S. TIPS ETF (SYMBOL SCHP, $63).

Other options include floating-rate notes (bank loans with interest rates that reset higher when market rates rise) or high-yield corporate bonds. These are riskier IOUs. The team at T. ROWE PRICE FLOATING RATE (PRFRX) is topnotch; VANGUARD HIGH-YIELD CORPORATE (VWEHX) takes a cautious approach. Hybrid securities, sharing characteristics of both stocks and bonds, are worth a look now. Consider VIRTUS INFRACAP U.S. PREFERRED STOCK ETF (PFFA, $25).

2 Lower Your Tax Bill

BENEFIT FROM YOUR GENEROSITY

Since the 2017 tax overhaul doubled the standard deduction, the majority of taxpayers no longer itemize on their tax returns. But if you make a charitable contribution before December 31, you may be eligible for a modest deduction even if you don’t itemize.

For the 2021 tax year, people who take the standard deduction can deduct up to $300 of cash donations to charity. The $300 amount is per person, so if you’re married, you can deduct a total of $600 on your 2021 tax return.

The deduction is limited to cash contributions—donations of clothing and household goods to your local Goodwill aren’t eligible. Contributions to donor-advised funds aren’t eligible, either (see “Your Guide to Giving,” on page 66). Keep a record of your contribution with your tax documents. For donations less than $250, you need a bank record, such as a canceled check or credit card statement. For donations that exceed $250, you should obtain a written acknowledgment from the charity that shows the date of the contribution and the amount and states whether you received any goods or services in exchange for your donation.

If you still itemize, you can deduct charitable contributions made before year-end on Schedule A of your 2021 tax return. As was the case in 2020, itemizers can deduct donations of up to 100% of their adjusted gross income. Ordinarily, the cut-off is 60%, but that limit was removed for the 2020 and 2021 tax years (although there’s still a 100%-of-AGI limit on all charitable contributions). Donations to donor-advised funds aren’t eligible for the higher limits. However, high earners may want to postpone major charitable gifts, for reasons we explain in the box on page 46.

KEEP MORE OF YOUR INVESTMENT GAINS

The stock market delivered another effervescent year in 2021, and if you sold some of the winners in your taxable accounts, you’ll be required to share a portion of your bounty with the IRS. Investments held for less than a year will be taxed at ordinary income tax rates, which range from 10% to 37%. Investments you’ve held longer are taxed at long-term capital gains rates, which range from 0% to 23.8%.

The most effective way to reduce your tax bill is to ditch some of your underperformers before year-end. If you sell investments that have fallen below their purchase price, you can use those losses to offset your gains. After matching short-term losses against short-term gains, and long-term losses against long-term gains, any excess losses can be used to offset the opposite kind of gains. If you still have some unused losses, you can use up to $3,000 to offset ordinary income and roll over any leftover losses to the following year. Once you sell an investment at a loss, you must wait 30 days before reinvesting in the same security or buying a substantially identical investment.

Even if you’re ordinarily a long-term investor, you may want to make some strategic sales in your taxable account if you’ll be eligible for the 0% capital gains rate. For 2021, single filers with taxable income of up to $40,400 are eligible for the 0% rate (it’s $54,100 for head-of-household filers and $80,800 for joint filers).

Keep in mind that your gains could boost your income above the 0% threshold, so you may want to sit down with a tax professional and calculate the amount of gains you can take before your income exceeds the cut-off. And if you’re retired, note that capital gains could also increase taxes on your Social Security benefits.

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